Irreversible capital and the stock market response to shocks in profitability

This paper develops a vintage model of capital accumulation to identify the structural linkage between shocks to input or output prices and a firm's stock-market value. The model accounts for a substantial part of the sample variation in excess returns, thus providing evidence for a systematic link between the stock-market valuation of firms and the economic factors that affect their profitability. The 1973-1974 oil shock is shown to have had a strong impact on excess returns; firms whose capital consisted of vintages built when energy was relatively cheap were hit the hardest in value.